Russia’s post-election economy

Now that the elections are over, the government must take a hard look at the promises that have been made, the reforms that need to be carried out, and where the money will come to pay for them.

The lack of opportunity for real political competition and the
alleged large-scale fraud in Russia’s recent parliamentary and presidential
elections gave rise to doubts in a significant part of society about the
government's unconditional legitimacy. This is extremely dangerous, because the
country will soon face a number of serious challenges, and the authorities will
have to solve many difficult social and economic problems, and will likely need
to use unpopular measures to do so – and this doesn’t take into account
fulfilling the campaign promises made by the candidates.

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President-elect Vladimir Putin himself estimates the costs of
the programs he proposed during the campaign at roughly 1.5 percent of GDP.
Experts have placed their estimates even higher. For example, the Center for
Macroeconomic Research at Sberbank calculated that all the election promises
added up to 4-5 percent of GDP, while the Fitch agency figured $160 billion, or
8 percent of GDP for six years. All of these potential dispensations come on
top of the government's previous commitments, including the spike in defense
spending that committed 20 trillion rubles up to 2020, as well as increased
salaries for the law enforcement and security agencies, and pensions. Add to
this the need to finance megaprojects such as this fall’s APEC forum, the Sochi
Olympic Games in 2014, and the 2018 World Cup, among others.

All this would be disturbing, but not frightening, if the
economy were growing rapidly and sustainably. Unfortunately, the obvious danger
of a deepening recession in Europe, the hard landing of China's economy
expected by many experts, and the unstable economic growth in the United States
are creating an extremely unfavorable context for the Russian economy, which is
critically dependent on export of raw materials. Even by the a priori optimistic official estimates, Russia's
GDP will not grow more than 3-4 percent per year in the near future, and that
is assuming continued high oil prices on the world market. The unfavorable
global economic conditions are superimposed on a number of time bombs left over
from the government’s previous tactic of "avoiding risky and unpopular
decisions.”

One of these is the long-postponed and well-overdue social
reform. First and foremost, this means pension reform; coverage of the
constantly growing pension fund deficit is now the largest item in the federal
budget. Meanwhile, reforming healthcare and education will also require
increased budget expenditures. Salary increases have already been announced for
doctors, teachers, and university professors, and promises were also made to
bring scholarships to the level of the minimum wage in the coming year. These
areas, especially healthcare, should also become priorities, because the rates
of life expectancy, level of morbidity, and infant mortality in Russia are
unworthy of a country with a claim to being a great power. And the list of
problems that are long overdue for fundamental reform could go on and on.

To these kinds of strategic problems should be added such
current troubles as the sharply declining trade surplus. Russia has still not
become an attractive country for investment. Moreover, during the 2008-2009
crisis and in recent months, there has been large-scale capital flight from the
country. Statements made during the election campaign about reviewing the results
of the privatization of the 1990s, a number of scandalous criminal cases
against entrepreneurs, and the continued appalling corruption hardly encourage
hopes for a fundamental change in this trend. As a result, it is unrealistic to
think that Russia’s possible current account deficit will be offset by capital
inflows. At the same time, prospects for modernizing the economy by importing
advanced technology from western countries are sharply deteriorating, as are
the possibilities of borrowing on foreign capital markets.

Debts have to be repaid. I recall that some years ago, the
Russian budget was balanced with an oil price of $30 per barrel. Now the budget
is balanced only if the oil price is $115 per barrel. A large and long-term
decline in oil prices will lead to fiscal disaster. Tensions over Iran mean
that energy prices are remaining at a level comfortable for the Russian budget;
but only a madman would count on their continued significant growth.
Furthermore, new technologies for extracting and transporting gas, plus the
introduction in the developed countries of alternative energy sources and
energy-saving programs, may lead to reduced demand for Russian energy supplies
in the medium term.

There are no economic miracles. To solve the inevitable budget
problems, we have to either lower costs (meaning minimally a marked slowdown in
growth) or increase the tax burden. The first carries a political risk, which
the authorities cannot accept given the doubts in the population about the legitimacy
of the government and the lack of consolidation of the elites. The second
option remains. It is no coincidence that even as a presidential candidate, Putin
spoke vaguely about "a tax maneuver." At the same time, under the
banner of social justice, ideas are being thrown around in public discourse
about a luxury tax and compensatory fees for dishonest privatization. The
option of raising taxes is extremely dangerous. Russian businesses, as everyone
knows, pay huge bribes in addition to official taxes. Nothing has yet really
been done to reduce these. Moreover, the vitally necessary restructuring of the
Russian economy and the growth of innovation require tax incentives, in the
form of differential tax cuts. We already have a very fresh experience of
raising taxes on wages. Its result was the collapse of economic activity,
primarily by small and medium-sized businesses, and the shift of
entrepreneurship to the shadow economy. This has fiscal implications, among
other things. The increase in such tax collection last year was 300 billion
rubles less than planned, because of the increased tax burden.

There is a global solution to the problem, and that is a sharp
increase in economic growth. Large-scale liberalization of economic life could
potentially provide this, coupled with a marked reduction in corruption and in
administrative pressure on business. True, its effect will not be felt
immediately. And alas, the authorities show absolutely no willingness to go
this route. But they should act before the course of events forces their hand.

Andrei Nechayev is the president of Russian
Financial Corporation, a professor and a former finance minister.